Johnston Press (JPR.L) – Negative Equity
As everyone who invested in Irish property over the past decade or so knows, equity is the difference between the value of your total assets and the value of your total liabilities. Another thing that every Irish property owner knows is that while the ‘value’ of your total assets can often be subject to wild swings either to the upside or downside, liabilities are much stickier. And as it is with property, so goes the traditional print media space, where investors have seen accountants significantly write down once extremely valuable newspaper assets, while debt levels have proven immune to such accounting adjustments.
(Disclaimer: I am a shareholder in Trinity Mirror plc and Independent News & Media plc) I have previously profiled two newspaper groups with a presence in the UK and Ireland, Trinity Mirror and Independent News & Media, in detail. In both cases, concerns around debt levels and extremely challenging (due to both cyclical – the economy – and structural – the threat of new media) market conditions have been to the fore. While the economy remains a headwind, both have made significant progress in improving their balance sheets. Trinity Mirror is the exemplar in this regard, cutting net debt by a third between FY09 and FY11 (to £201m), without recourse to its shareholders, while over the same period its net assets have risen by 38% to £675m. Over the same period INM has cut its underlying net debt by 26% to €427m (its movement in net assets is not particularly meaningful due to the impact of the deconsolidation of its Australasian business and other disposals).
Today I look at one of their peers, Johnston Press (JPR), which has faced similar balance sheet and economic pressures in recent years. The group publishes 13 daily newspapers, ‘more than 230’ weekly newspapers, ‘glossy monthly lifestyle magazines’ and 223 local websites in the UK and Ireland. Its flagship brands are The Scotsman and the Yorkshire Post, while Irish followers of this blog will be familiar with titles such as the Leinster Leader and Kilkenny People.
It has faced what can only be described as savage pressure on revenues due to the recession. Between 2007 and 2011 its total advertising revenues declined by 47% to £231m. All categories have been impacted by this, with employment advertising -75%, property -62%, motors -49%, ‘other classified’ -26%, display -24% and Ireland -63% over that period. Revenue from newspaper sales has held up much better, falling only 7% to £96m, while over the same period its very profitable contract printing business has seen revenues fall 23%.
In total, the group saw revenues fall £234m over the 4 years to 2011. Half of this was offset through reduced operating expenses, but the remainder hit the bottom line, with operating profits falling over 60% over the period to £65m. The diminished profit outlook has seen JPR book impairments against its intangibles (chiefly, the print assets) totaling £720m since the start of 2006.
This brings us back to the housing analogy of the opening paragraph. Due mainly to the impairments noted above, the book value of JPR’s assets has fallen by nearly half – from £1.9bn to just under £1.0bn – since the end of 2007. At the same time, the company’s level of gearing has risen from 98% in FY07 to 126% at the end of last year. It should be noted that net debt, in absolute terms, has been falling (FY07: £671m, FY11: £359m), helped by share sales totaling £207m over the past 4 years. Despite that decline, at the end of last year net debt stood at 4.1x EBITDA, which is an uncomfortably high multiple.
Earlier this year the group agreed the amendment and extension of its finance facilities until 30 September 2015. While this facility reduces the near-term risks around the group, it does not come cheap, as shown in this extract from JPR’s H112 results release:
The maximum cash margin in the case of the bank facilities is LIBOR plus 5.0% and in the case of the loan notes, a
cash interest coupon of up to 10.3%. In addition to the cash margin, a payment-in-kind (PIK) margin of a maximum
rate of 4.0% will accumulate and is payable at the end of the facility. If the loan facilities are fully repaid prior to
31 December 2014, the rate at which the PIK margin accrued throughout the period of the agreement will be
recalculated at a substantially reduced rate.
Looking through JPR’s accounts shows the diminished flexibility imposed on the group by its borrowings. Between 2009 and 2011 it generated some £227m in operating cash flows, but of this 37% went on interest payments and another 58% on repaying borrowings, loan notes and reducing the bank overdraft. This leaves very little for investment, and I was unsurprised to see capex average only £3m per annum over the period, down from an average of £40m per annum over the preceding 3 years. Given the ‘incentive’ to repay (or, as seems more likely, refinance) the facilities before the end of 2014, I would expect to see more of the same over the coming years. Which means no dividends (extremely unlikely in any event given the large stock of debt outstanding), no (meaningful, at least) acquisitions and limited resources (as I see it) for the group to effectively execute its digital-led strategy. On that note, while digital represents the great hope for traditional media, monetising it is proving a challenging task – in FY11 digital advertising contributed only £18.4m of JPR’s revenues, a rise of circa 20% on 2007 levels.
In terms of the valuation, at first glance Johnston Press appears very cheap, trading on less than 2x prospective earnings at its current share price (5.85 pence). However, it is important to note that the group comes with considerable net debt (£332m at the end of July) and a large pension deficit (£102m at the end of June). I ran a DCF valuation on the group using my usual 10% discount rate and applied a -2% terminal growth rate, which produced a negative equity value of -27.5 pence a share. However, it should be noted that this estimate is extremely susceptible to changes in the inputs – for example, every £10m move in the pension deficit moves my equity value by 1.6p. Excluding the pension deficit altogether (I always include it in my DCF calculations) produces a valuation of circa -11p a share. But if Johnston Press really has a negative equity value (in practice, zero, given that a share price can’t go below that!), then why is the share price at 5.85p and not closer to zero? I imagine that investors are betting on an eventual cyclical recovery in advertising, and I can understand why they would be making that bet – as I note above, while advertising revenue has effectively halved from the peak, newspaper sales has fallen by less than a tenth over the same time period, which to me indicates significant operating leverage that could accelerate debt paydown and transform the share price outlook if advertising was to stage a recovery.
Overall, my sense is this – if there is life in traditional print media (and I believe there is, hence why I’m long two stocks in the sector), Johnston Press represents a very high risk way of playing that theme. I feel that its hands are tied by its legacy debts, which limits the scope for investment, and there is a danger that equity investors could be significantly diluted (the firm has already agreed to issue warrants totaling 12.5% of its share capital to its lenders). Of course, were the outlook to improve, then the implied equity valuation would recover in tandem with that. However, at this time I see nothing in JPR to justify adding it to my portfolio either instead of or alongside my existing UK print media holding, Trinity Mirror. Both stocks are exposed to the same macro trends, but their balance sheet positions are fundamentally different – at the end of FY11, JPR’s net debt / EBITDA was 4.1x, while for Trinity Mirror it was just 1.6x. My thesis for some time, given the structural long-term decline that is underway in the print media sector, is that the financially strongest will be able to mitigate against a shrinking revenue pie with market share gains as weaker competitors close underperforming titles. Given that stance, I am happy to be a shareholder in the UK’s biggest regional press publisher, and not in the third biggest one.